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Williams-Sonoma – Bricks & Mortar or Online Shopping?

With the inevitable growth of online shopping, there’s been plenty of discussion about the vulnerability of traditional bricks and mortar retailers who are not responding quickly enough to this global trend. And really, they don’t have a choice but to try to respond – in the U.S., online sales grew in the mid-teens whilst sales of traditional bricks and mortar retailers grew at 1.4% in 2015 according to research by JPMorgan.

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By now, most of these traditional bricks and mortar retailers have started their own online offerings and many have used their existing storefront footprint to offer more flexible delivery and pick up options for their customers, which has greatly improved their user experience and bolstered average sales per customer (for example, Williams-Sonoma believes their multi-channel customers spend 4 to 5 times more than their single channel customers). However, for these traditional bricks and mortar retailers, they face a balancing act of growing their online business at the risk of cannibalising their existing store front business. So how will they walk this tightrope?

Williams-Sonoma – the evolution to online sales

One company that is managing to walk this tightrope is Williams-Sonoma (WSM US), a New York listed retailer of home furnishings and accessories with a market capitalisation of A$6 billion. The company owns a suite of well established brands including Williams-Sonoma, Pottery Barn, Pottery Barn Kids and West Elm, which together generated US$5 billion in sales in 2015 with ambitions to reach US$7 billion in sales by 2020. In Australia, you may have seen their stores open in recent years as the company has opened 19 stores in the last four years.

Over time, the company has expanded its brand portfolio and created new retailing concepts to target different demographics and price points and ultimately, drive growth.

Despite having a global network of 618 stores (571 in the U.S.), what may be surprising is that Williams-Sonoma generates just over half its sales from e-commerce channels having launched its own websites in 2000. Since then, e-commerce sales have reached US$2.5 billion and grown at a 27% compounded annual growth rate.

The company’s history of marketing via its shopfronts as well as through a paper catalogue meant that Williams-Sonoma recognised early on the power of multiple distribution and marketing channels. It saw e-commerce as a natural evolution from its paper catalogue business and was one of the first traditional bricks and mortar retailers to really embrace the online channel.

As such, it has the highest penetration rate of online sales amongst all U.S. traditional bricks and mortar retailers (Staples, a retailer of office products also has a similar penetration rate of 50%).

Again, this may also be somewhat surprising given the category in which Williams-Sonoma services – home furnishings and accessories. Traditionally, it was thought that large bulky items didn’t necessarily lend themselves well to an online shopping experience but over time, the consumer has become very comfortable purchasing such items online. The category of home, garden and furnishings now makes up 8% of U.S. e-commerce sales and seen its annual growth rate increase from 7%-8% in 2011 to 15%-16% in 2015.

And intuitively, the fact that Williams-Sonoma has store fronts allowing consumers to physically view the product before they either buy in store or online, helps the purchasing decision of their customers. Perhaps this partially explains why a pure online home furnishings company such as Temple & Webster (TPW AU) in Australia has struggled to be profitable and is considering opening up a store front in 2017.

Being online is just the beginning

Williams-Sonoma believe there are several other factors that play an integral role in succeeding in retailing, namely:

Data-driven marketing, which allows for a better understanding of the customer and assists the retailer to target and personalise their offerings and promotions to specific customers. Williams-Sonoma has 60 million households in its database and believes that it generates 50%-80% of new customers from its internal marketing campaigns

Strong margins but these are coming under pressure

Given the online penetration of its overall business, Williams-Sonoma has managed to achieve gross margins of 37% and operating margins of 9.8% (for the 2015 financial year). This has been driven by the company’s online business, which grew sales at 6.4% in 2015 versus 5.4% for its traditional bricks and mortar business. It’s online operating margins were 22.3% versus overall operating margins of 9.8%.

However, its online sales growth has slowed from averaging 13% per annum between 2011 and 2014. In 1Q 2016, online growth was 8.2% with online sales contributing 52.5% to total sales. Gross margins were 35.8% and overall operating margins fell to 7.0%. This was due to investments in its supply chain and higher inventory levels during this time of the year. The question is whether this is indicative of continued margin pressure as the company faces rising costs in its supply chain and fulfillment process.

Nonetheless, for its 3-year growth outlook, Williams-Sonoma is guiding for mid to high single digit revenue growth and earnings per share growth of low double digit to mid-teens. This is consistent with the recent 2010-2015 period, where the company grew revenue at 7% per annum and earnings per share at 13% per annum.

Williams Sonoma trades on a 14.5x 2017 price / earnings multiple which is comparable to other traditional bricks and mortar retailers and a significant discount to pure online retailers. But with margins more similar to pure online retailers, it’s arguable that Williams-Sonoma deserves to trade on a higher multiple. The answer probably lies in whether we consider the company is a traditional bricks and mortar retailer or an emerging online retailer navigating that tight rope between these two channels.

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